This blog has been created to pen down my thoughts on value-based investment opportunities (or the lack of them) in Indian listed companies. As an enthusiastic reader and life-long student of Behavioural Finance, i also plan to blog on various aspects of investment psychology.

Wednesday, January 25, 2012

Last week, I spent some time at Elecrama 2012, an industry exhibition of power transmission and distribution (T&D) players, held at Nesco Exhibition Centre in Mumbai. Hundreds of companies, listed, unlisted, domestic and foreign had their stalls at the exhibition.

I often interact with a lot of industry people (who have no idea of finance/stock market) to understand the ground level realities of a sector/company. Visiting such exhibitions is even better, for two reasons:
1) You get to meet a lot of industry experts from varied sectors at one place.
2) Usually, the stalls are not manned by finance people, but by technical/marketing people. So the view we get from them is totally unbiased. They have nothing to say which can help the stock market price of their company! :-)
(In case you doubt my motives for going there, lemme tell you upfront that the food there is usually horrible!)

The exhibition was by players belonging to the power transmission and distribution industry. Transformers, switchgears, wires, various EPC players, etc were all present. Here are some notes I gathered from my interaction with various people representing various companies from various sectors over a period of 4-5 hours at the exhibition. These are not my own views.

Major problem is coal
Yes, there were no power generation companies there, only transmission and distribution ones. Still they rued about the non-availability of coal. Here's why; without proper coal availability and linkages, power generation capacities cannot come up as scheduled. The T&D work starts only when there is proper view on when the power generation will begin, so that there is seamless transmission of electricity. Without coal, generation is hampered. Without a view on when generation will begin, the down-stream T&D work comes to a standstill. Effectively, the entire process comes to a grinding halt. Coal India, THE supplier of coal in India is facing a tough time ramping up capacity. Proper coal linkages, therefore, are a critical value driver for the entire power-ancillary sector.

Working capital is proving to be a major strain
With overall liquidity in the system not at very great levels and with mounting losses and pressure on SEBs, recovery is proving to be a major problem. A lot of the players gave feedback that business is there, but we are not taking it because we do not know when the customer will pay up! 3-4 months has become a usual time for recovery in most cases. This puts strain on working capital. Companies will not sell more if they do not have working capital to support increased sales. This puts companies' topline in danger too!

Irrational competition is hurting
Competition has become fierce. Even the Koreans and the Chinese are trying to get into the Indian power ancillary market in a big way. (Although there are certain laws to protect Indian companies). Due to intense competition, a lot of companies are pricing their products at substantially lower margins, just to keep the topline going! The industry faces severe pressure on margins in the next future (at least a couple of quarters). This problem seemed more severe on the EPC side (transmission lines, sub-station erection, etc). Players do not expect pricing sanity to return very soon.

Solar is the next big thing
Surprise surprise!! Almost every industry person from varied sectors I spoke to said the same thing. Solar energy is going to be really big! But what about the very high cost of generating solar? What about rational pricing? What about financing for the same? Even the lowest cost for generation quoted recently (Rs.7/unit) is wayyyy higher than the cost of producing thermal power. Also, what about fast changing technology? Whatever solar power projects are being put up now, will they not become obsolete in maybe 5 years from now? So how can one say that solar is the next big thing? To alllll these questions, I got only one answer; solar will be big because the Government wants it to be big! Everybody admitted that there are some irrational things going on in solar power sector. Down the line, there will be huge growth, some players will burn their hands, unviable projects will go bust, sure! But the sector will become huge! Thats what they said! This also gives an opportunity to power-generation-battery makers like Exide. (Like they got a big boost in sales a few years ago during the telecom tower craze!)

Wheels are slowly turning, but even a snail would overtake!
The industry people reported that some improvements are happening. SEBs are being cleaned up, orders from Powergrid have resumed in decent volumes over the last two months and Government has recently started taking some serious steps to tackle the coal shortages. But the process will be slow and will cause pain to a lot of players till it catches on properly. Good old times are at least 2-3 quarters away, they say.

Well, there you have it. Some info about the power sector. I find this sector really interesting, inspite of majority of the players in it not making cash-flow and spending a bomb on working capital. Another interesting article from The Economist about the sector makes a nice read. Do go through the same.

Cheers and happy investing!!!

P.S. Came across something interesting recently. Its a book, which I do not think is released yet. Do check it out. The basic premise of the book seems very interesting, worth keeping tabs on the it.

Sunday, January 8, 2012

I often talk with a few value-based investor friends and discuss products, industries and ideas. Its quite amazing that usually there are very few common ideas between us. Almost everyone has portfolios consisting of different stocks. So it was quite a surprise that a coupla weeks ago, me and my good friends Ninad and Rohit discovered that all of us have been independently looking at Nesco Ltd. So we decided that without discussing our individual thought processes, all three will write about Nesco on our individual blogs and post it at the same time. We thought that it would be an interesting exercise for the three of us as well as the many readers of Ninad's and Rohit's blogs and the few readers of my blog to see how three different investors, though value-based, will look at the same company from different angles. (I hope the angles will be different!) The idea is not to see who is right or who is wrong. All three of us know that even if we reach a consensus, all three of us could be very wrong and even if all of us have different conclusions, all three could be very right! Well thats the best thing about investing, there is no one way of doing things!

You can check out Ninad Kunder's post on Nesco here.You can check out Rohit Chauhan's post on Nesco here.

After reading the two posts, if you are still left with some patience, here goes mine!

Nesco is a BSE, NSE listed company. Market cap stands at Rs.780 cr (at CMP Rs.555), with promoter holding of 62%. Not the most liquid stock! CMD is Mr.Sumant Patel. His son Krishna Patel joined the Board in FY08 and is now an ED.

The company has three divisions:

Exhibition centre (BEC): The Company owns and lends out the Bombay Exhibition Centre. Its a 4.5 lakh sq ft centre at Goregaon on Western Express Highway.

IT buildings: The company has constructed and leases out buildings to IT, ITES companies in the same complex at Goregaon (65 acre complex). Currently, there are 3 buildings with a combined area of 10.4 lakh sq ft. 4th IT building has also been announced. This will be a 9 lakh sq ft building entailing a cost of Rs.200 cr. About half of the total land asset has been used up till now.

Engineering business: Indabrator supplies surface preparation treatment plants to various industries. The business is quite lumpy, to say the least.

I am not looking at valuing the company based on its ‘existing land asset’, which will be a few times more than the market cap. I do not think that’s the right approach, since the company is pretty clear about not monetising the land asset.

Prof Bakshi's report gives a very detailed view of the business; there’s nothing much I can add about the business and its working, it’s extremely well explained in the report. I strongly request you to please go through the Prof's report.

Now that the details of the business are understood, what I will do is put up my thoughts on Nesco, as an investment opportunity.

Positive arguments:

The company’s strategy would appeal to any conservative person. Construct a building, lease it out, milk it for a coupla years and with the cash accumulated, build one more! Quite averse to debt. (This may be taken as a negative, but they never stretched themselves because of this policy.)

New buildings are built only after proper feasibility study to ascertain whether the supply can be absorbed. This ensures that buildings don’t remain empty. Also, time intervals between buildings means that the company can generate enough cash for constructing new buildings.

Fantastic payback period on incremental assets created, because of absence of land cost. (IT Building 3 was constructed at a cost of Rs.150 cr. Yearly rentals, at full capacity, should be at least Rs.70 cr. About 2 years payback!!)

Decent management: The conservative actions of the management have helped it negotiate the twists and turns of the sector. On the flip side, one may argue that they haven’t been aggressive enough. I am in the former camp. I did not find anything blatant in the ARs of the company to raise doubts about their integrity. Here, I should clarify that I have never interacted with the management or attended the AGM. The management does not even take the full remuneration they are entitled to, even though there is approval for the same. Also, their whole professional approach while going in for a new building appeals to me.

I read about a lot of corporate offices moving from South Mumbai to Goregaon-Andheri area. (One can counter this argument by talking about healthy supply in Nesco’s area. I believe Nirlon also has land there)

A base-case valuation:

Since this is an annuity business, I have valued it using DCF as follows. (PAT is almost equal to cashflow, since there depreciation is less and 'working capital' is not required.) Please check the assumptions behind this DCF. You will find them to be 'conservative', to say the least! :-)

Click to enlarge

Assumptions:

1) There will be no additions to existing buildings, there will be no increase in rentals of BEC and IT buildings. (Basically, zero growth scenario)

2) Additionally, I have taken the lease rentals for IT buildings at about 10% lower than existing rentals.

3) The entire infrastructure will last for 30 years. Hence, only 30 years DCF done. No terminal value considered.

4) Total expenses (including depreciation) taken at 30% of revenue.

5) 'Other income' has not been considered. (Although this was Rs.17 cr in FY10 and Rs.10 cr in FY11)

6) Full 35% tax on PBT taken.

7) Cash on books taken at Rs.130 cr. (Deducting capex left for IT Bldg 3)

8) Engineering business not considered (although it has been performing well at present.)

9) Discounting rate taken: 15%

The DCF gives us an IV of Rs.460/- per share. (Changing assumptions, discounting rate, etc will, of course, change the IV.) So, it seems that at Rs.460, the market will be valuing Nesco as a zero-growth stock. Whether there will be zero growth in the company? Well the management has disclosed intentions to gradually go for IT building 4, 5, 6 and 7, double BEC capacity to 9 lakh sq ft and also construct a five star hotel. Specifics for IT building 4 have already been announced (9 lakh sq ft, Rs.200 cr capex). That’s not exactly ‘zero growth’! So, at Rs.460, Mr.Market will be (irrationally?) valuing the stock as a zero-growth stock. (This approach I have used is actually Mauboussin's Expectations Investing approach, which can be used to find out what the current price of a stock implies. Basically, we try to find out what Mr.Market expects from the stock at current market price and then check whether Mr.Market's expectations are justified or are they toooo pessimistic or optimistic. As Munger says, invert, always invert!)

Negative arguments (of course!)

The company’s business is very susceptible to macro slowdown. BEC revenues will be especially hit and IT building rentals will come under pressure. This is more of a systematic risk and will affect equities as an asset class on the whole, not just Nesco. Also, slowdown fears in Mumbai real estate market are being talked about. This can affect the IT buildings part of the business.

The company pays pathetic dividend of Rs.2.5 per share. Payout is about 7%. If one wants to hold on to this stock for extended periods of time (8-10 years or so), absence of meaningful dividend payout will be a deterrent for any investor. However, in my view, it is criminal to ask this company for dividend! The cash is better left in the company’s hands! Payback period in incremental IT buildings is 2-3 years! How much will a shareholder earn out of the money he receives as dividend? Surely not as high! However, I think that absence of large dividend payout has been depressing the valuations of the stock (irrationality of Mr.Market?) Over a period of time, the sheer quantum of earnings and cashflow should be so large, that Rs.750 cr market cap would appear just too less. (upon completion of IT building 4, PAT, which is effectively cash earnings could be as high as Rs.150 cr)

I think that the biggest risk against investing in this company is capitalmisallocation. Until now, the management has not done any hanky-panky in the business. They do not even take remuneration which they are legally entitled to! However, risk of capital misallocation exists in following cases:

-The company proposes to construct a 5-star hotel on part of its land. If the company decides to operate it on its own, without going for the fixed income/leasing model, I think it would be a massive misallocation of capital.

-The management seems to be sentimentally attached to the engineering business, which has not exactly been doing great, struggling to break even. The management also expressed its ambition to be no.1 in India and among the top 5 in the world. With ample cash available, if they decide to put a greater part of it into engineering business, the returns on the same will not be as attractive as the lease-out business.

-The company has been dabbling a bit in equity mutual funds. (Rs.10.5 cr in equity funds against Rs.150 cr in debt funds as on 31st March 2011). However, if the management feels that they are Buffett part-2 and decide to get a lot into equity (directly or through MF route), there would be much additional risk. I believe that they should leave the act of making losses in equities to us professionals! ;-)

- The company is currently in a rolling phase. Cash earned from existing assets is ploughed back to create new assets, which are substantially cheaper due to almost zero land cost. However, the question remains.. let’s say after 10-12 years when they completely exhaust all their land, what will they do with the cash they generate. Family managed companies have the tendency to neither disclose their intentions, nor to treat other shareholders as ‘owners’.

During real-estate-craze-times, the stock gets bundled up with all the other land bank stories and runs pretty wild. (Some may not take this as a negative point!)

Overall opinion

In my view, Nesco presents a decent opportunity where a high quality business and a conservative management is combined with a first-class asset base, which is being exploited slowly. Intrinsic value in this case would be more like a moving target (based on the mgmt plan), hence I have not gone into the same. What I wanted to look at more is what the current valuations accorded by the market imply? I think that below Rs.500, the market starts giving it a zero growth valuation, which seems to be more on the irrational side, presenting an opportunity.

Cheers and happy investing!!

Disclaimer(s)!!1) All the posts on this blog, including this one, are for educational and discussion purposes only.2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.3) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours!

Thursday, January 5, 2012

Hello folks. Wish you all a happy new year and I sincerely hope that investing-wise, it does not turn out to be a crappy new year! :-)

Its been almost an year since I put up an update on previous posts I had made and I think it is time to bore you again. There is a lot of stuff I write, which is not stock-specific. I don't think I should bore you more with updates on that, hence I will update only about the prior stock-specific posts.

In March 2011, I had written about some amazing things that Sharp India was doing. I re-iterate that I will not touch the company's shares with a 20 ft pole.

In April 2011, I had written about Disa India and had followed it up with AGM notes on the same. The price is virtually at the same level. The company has had a coupla quarters of good performance. However, the business is lumpy and this should not be extrapolated. I am not buying the stock at present.

In May 2011, I had written about SBI's subsidiaries and had followed it up with an update. I was of the view that the stocks were not very attractive at the then prevailing market prices. Since then, the prices have dropped decently. I think the stocks will start becoming attractive on further drops. I have built a small initiating position in one of them.

In June 2011, I had written about Goodyear India. I have never had a position in the stock. The post was basically for inviting views from readers. I had some good interactions with a few people over email on the topic.

In July 2011, I had written about Kesar Terminals. The company has announced some expansion plans but has not disclosed the financial aspects of the same. Please check out the BSE announcements regarding the same. I am no longer invested in the stock.

In July 2011, I had written about Balrampur Chini using a mind-map approach. This is the first time in my 8-10 years in the market that I have looked at a sugar stock. The stock price has fallen since then and I have been steadily nibbling into it. I have left decent room to add more on further declines. I have no idea about when the sugar cycle will turn. :-)

In October 2011, I had written about Network18 Preference Shares, with a view that they were too risky for my taste. The price of the shares has appreciated from Rs.105 to Rs.122 since my post, mostly due to some interesting recent events. :-) I still maintain that they are too risky for me and I have no intention of buying the same.

In November 2011, I had written about Bharat Bijlee with a view that the time was not yet right for buying. Even though the stock LOOKED cheap, it was not THAT cheap. The price has fallen from Rs.700 to Rs.540 since my post. I will be eagerly looking into the December 2011 quarterly results to see the position of the business.

In November 2011, I had written about Triton Valves. I had analysed the company strictly on quantitative basis and it was not a good opportunity, in my view. The stock price has dropped from Rs.500 to Rs.370 since my post. I still have no intention of buying the same.